THE M3: UNEMPLOYMENT UNCHANGED

The Macau Metro Monitor, October 27th 2010

EMPLOYMENT SURVEY FOR JULY-SEPTEMBER 2010DSEC

The unemployment rate for July-September 2010 remained unchanged from the previous period (June-August 2010) at 2.9%. The employed population increased by about 2,700 over the previous period to 320,200, in which employment of the Gaming Sector and Wholesale & Retail Trade both saw an increase. Total labor force was 329,600 in July-September 2010 and the labour force participation rate stood at 71.8%, up by 0.4% point from the previous period. Number of the unemployed held stable at 9,400, with 19.0% being fresh labour force entrants searching for their first job, up by 1.8% points over the previous period.

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10/26/10 07:11 PM EDT

BWLD – FIRST LOOK

Conclusion: Results were slightly ahead of expectations but commentary indicated that current trends are sluggish. However, on a two-year average basis the early trends in the fourth quarter continue to demonstrate acceleration on a two-year basis.

BWLD’s 3Q10 earnings came in at $0.47 per share, better than both my estimate of $0.45 per share and the street’s $0.44 per share estimate. Company-owned same-store sales grew 2.6% in the quarter relative to the street’s 1.8% estimate, implying a 35 bp acceleration in two-year average trends. Given the strong top-line trends and favorable food costs, which declined 185 bps YOY as a percentage of sales, restaurant-level margins improved about 110 bps YOY (putting BWLD in the Nirvana quadrant of our restaurant sigma chart). The decline in the cost of chicken wings (down 15% YOY) drove the majority of this YOY food cost favorability. The company’s reported tax rate of 30.4% came in lower than I was modeling and added about $0.02 per share relative to my numbers.

Although the company reported that company-owned comparable sales declined 0.7% during the first four weeks of 4Q10, this points to a 90 bp increase in two-year average trends since the end of 3Q10 as the company was lapping a difficult +5.9% comp from the first four weeks of 4Q09. To that end, the low end of management’s 4Q10 comp guidance of “at least flat” is somewhat disappointing as the comparisons get easier for the balance of the quarter and a flat comp in 4Q10 implies a 40 bp slowdown in two-year average trends from 3Q10. Same-store sales growth at franchisees slowed about 40 bps during the third quarter on a two-year average basis and trends during early 4Q10 remained in line with 3Q10 results. And, the company’s FY11 EPS guidance of over 18% growth falls short of BWLD’s more typical 20%-plus range. On the earnings call, management explained that earnings growth will be limited somewhat by higher YOY preopening expenses and increased investment internationally. Management said its FY11 forecasts are still preliminary, however, and for now, they are being conservative, but they will give more guidance on expected earnings growth come their 4Q10 earnings call.

Relative to expected food costs in FY11, the company has extended its contract on boneless wings (represented 19% of 3Q10 sales) through March 2012 at prices about even with 2010 levels. Although traditional wing costs (represented 21% of 3Q10 sales) have proven extremely favorable during the last two quarters and should continue to benefit margins in 4Q10 (about $1.51 per pound versus $1.78 in 4Q09), management said prices continue to fluctuate monthly and are one of the biggest unknowns relative to the company’s current commodity outlook. That being said, the company currently expects traditional wing costs to be beneficial to margins on a YOY basis and is planning to implement a menu price increase in January, resulting in a cumulative 2% menu price increase for 1H11.

Howard Penney

Managing Director

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10/26/10 06:08 PM EDT

PSS: Ready, Shoot, Aim

There was an odd disconnect in leaving the PSS meeting late last week. The analyst side of us was quite content. “Ok, story on track. Check the box. Now let’s move on.” But unfortunately, there’s also the part of us that has to answer those ‘freak out’ questions around “what are we missing? Why’s the stock down? What are they comping this month? What did Matt say?”. After letting the dust settle for a few days, we’re still squarely in the ‘check the box’ Camp.

We have a complete review of the event below, but there were two standouts that put the Street in ‘freakout’ mode.

Freakout #1: For the first time, PSS articulated a clear long term earnings growth model, showing how it will deliver 3-5% top line and leverage that to 12-16% EPS growth. Like any portfolio, some areas will outperform, and others will underperform. But the net should be mid-teens. But the ‘freakout factor’ was due to domestic Payless coming in at flat-lsd in the long-term model. That, of course, triggers the question as to why it is acceptable for their core business to be flat. We’d answer that 3 ways.

1) If a flat core equals a zero-growth cash flow model, then we agree. But we’re talking about using the cash cow to fuel the PLG business (Sperry and Saucony, in particular) as well as Payless International – which have far better growth characteristics.

2) Do you think that just MAYBE this management team is tired of having egg on its face and wants to set long term goals that are achievable, and even beatable? The answer there is yes.

3) Lastly, as it relates to mid-teens EPS growth, though not the intent, our sense is that management would have softened up that meaningfully if current trends did not support those kind of numbers.

Freakout #2: The ‘A’ Word. [We’re going to get heavier into vetting acquisition candidates – some could be sizeable.]

Ok, now THIS is a concern I agree with. Last time around, when PSS bought Stride Rite, it inadvertently topped the credit market, housing market, and consumer spending cycle. Yes, it was totally overpriced, and the timing was aweful. The one thing that bugged me was a reminder by management that ‘we only had two weeks to vet the deal before making a decision.’ Based on our conversations with the team, they’ve got a real process this time around to vet any potential deals. If push comes to shove, they’ll bow out in a heartbeat.

But are acquisitions necessary? We’ll never justify paying for the hope of landing a good deal. But facts are facts, and Saucony and Sperry combined generate ~$450mm in revs up from ~$270mm in 2007 and now account for approximately 35% of the company’s EBIT. Also, with the percent of directly sourced product at domestic stores hovering at 73% (up from 30% 5-years ago) we think that PSS has simply become too slow. Our sense is that the company will downshift that percentage by at least 10 points over the next year. But in addition, a smaller acquisition of product exclusively sold at Payless might be a good traffic driver.

I hate to give a statement that is so cliché, but one thing that is clear is the depth of the bench at this company. Find me another company – in any space – that literally has its 20-top managers available in one room at the same time to a group of 20 sell side analysts and 40 investors. One smart young lad and I were talked after the meeting and he said something like “when I listen to these guys present, it makes me think I’m listening to a management team of a $5bn Enterprise Value company. Not one that is struggling to keep its head above a billion.”

So let’s take this full circle. We walked away thinking that the story is on track.

OTHER DETAILS OF THE MEETING

Despite consolidated growth expectations of 3%-5%, we believe some investors were expecting more robust growth from the domestic business, or even a major “we have it all figured out” announcement. But put into context, even if we assume flat domestic sales over the next 3-years, the PLG segment has substantial upside from low-to-mid teens growth in our view. With Sperry and Saucony combined accounting for just over 50% of PLG sales (~$450mm), Saucony has been a consistent 20%+ grower with sales recently trending north of 30% (see chart below). Moreover, in addition to the build out of retail stores, Sperry is continuing to aggressively ramp its women’s business. With roughly 7 stores by year end and approximately 15/yr going forward, we estimate retail growth alone will account for ~5% annual growth in PLG. Women’s represents an even greater opportunity. According to NPD data, women currently represent ~20%-25% of Sperry sales, which may be slightly understated but is 4x-5x year ago levels on an apples to apples basis. Based on discussions with management, expectations are to have womens at 50% of sales by year end implying over $50mm in incremental sales over the next year – another 6%-8% growth in PLG. While calling fashion is certainly not our specialty, what we saw in KC in initial product from Sperry’s new head designer was a drastic improvement from what customers have been accustomed to from the brand. Lastly, the brand is also benefiting now from a materially improved tiering strategy that was simply not in place 6-months ago with more product being flowed through the higher priced department store channel.

One additional comment on the flat domestic outlook – the company’s expectation for accessories (including apparel) to grow from 10% in 2010E to 12% by 2012 implies a ~$330-$340mm business growing 10%-15%/yr to $420-$440mm in 2012 adding another 1%-2% growth to consolidated top-line.

Sperry Top-Sider Store Walk:

Opened first store opened in Feb 2010 (at 5 in total) with another 2 before year end (Burlington, MA & Westchester Mall, NY in mid Nov.)

Distribution: The first initiative of Bill Bettencourt, SVP of Sales, Marketing, and Business Development, after joining the firm in May 2010 was to properly tier the product by channel

Sperry developed the Compass line (more value) for the mass channel

Tiered product more by design differentiation than price

Select product is now released downstream on a lag (e.g. a style launched at Nordstrom hits shelves at Dillard's 3-months later)

Apparel & Accessories: Company findings from focus groups suggest that consumers are challenged with how to match product with apparel

Starting next month,PSS will be working with a partner showcase apparel along with the footwear in an effort to help educate the customer – the byproduct is acquiring an acute sense of what resonates with the Sperry consumer as PSS looks to pursue its own branded opportunity in the channel

AUR has been above plan all year as well as less promotional

Head designer Bradley started roughly 12-months ago – product just starting to flow through now (Fall 2010) and has been very well received so far

Anecdotes:

Saucony:

Selling into FL well, great representation at new Run concept

Less enthusiastic re FINL - appears to be diluting their offering on the margin

1) Appears conservative though little upside in setting the bar high when sentiment is already low

While some expected more robust growth from the domestic business, smaller segments CLI and PLG appear to have upside

Acquisitions:

Rubel first mentioned acquisitions as in the bolt-on kind, then suggested the possibility of a larger deal later in the presentation - this is after being more focused on share repurchase and debt reduction following Q2 results

Company hasn't made a transformative deal since Stride Rite in 2007 - this likely raised concern among investors given the length of integration

Lecturing Myself On Shorting, Part II

This note was originally published
at 8am this morning, October 26, 2010.
INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK
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“Learn to fail with pride and do so fast and cleanly. Maximize trial and error, by mastering the error part.”

-Nassim Taleb

Before I shorted the SP500 on October 13th, I wrote an Early Look note that was titled “Lecturing Myself On Shorting.” I shorted the SP500 again yesterday, so I figured I’d call this morning’s note Part Deux. Immediate term tops are processes, not points.

Chapter 1 of Pablo Triana’s “Lecturing Birds On Flying” provided some food for thought in my initial note and this morning I’ll review Chapter 2, “The Financial Economics Fiefdom” where Triana takes the ball right up the middle on the academic dogma that permeates the US economic system.

On Milton Friedman – Triana argues that the heart of Friedman’s economic theory is that “theories should not be judged based on the realism of their assumptions.”

On Business School – Triana writes on page 37 that, “In sum, B-schools discarded tangibly accurate knowledge and information while embracing what may be deemed as analytical make-believe.”

On Herbert Simon – Triana reminds us that it was Simon who “held behavioral parapet, embracing observation-based empiricism and avoiding dogma-based economic theory.”

Most financial types know who Milton Friedman was but couldn’t tell you much about Herbert Simon. As I read Triana amplifying his point by calling out Simon’s name, I couldn’t help but smile.

Herbert Simon wrote one of my favorite multi-factor modeling books, “Models of My Life.” Charlie Munger recommended it at one of Berkshire’s annual meetings. As Triana points out, Simon was a Hedgeye kind of guy - he “ruthlessly ridiculed the financial economists’ assumptions about human action.”

My analytical team doesn’t wake-up every morning looking for someone to chirp. Keynesians are easy targets right now. They missed Jobless Stagflation in the 1970s too. Fed Chief Arthur Burns opted to monetize US Treasury debt and a Debauched Dollar was the result. Back then, the Nobel Prize in Economics was a new award. Today, some of the biggest risks in life are associated with investing alongside the academic premise of a Nobel winner.

This is where the likes of Simon, Soros, and real-time market practitioners of daily risk management take over the game. Anytime we see someone talking up an economic theory (QE2) that we’d have reserved seating for in the cheap seats, we’d just as soon call these wannabe market players out for who they really are. They travel in packs and are rarely accountable to their theories where it matters – on the tape.

On page 41, Triana offers a solution to this mess. He writes that “once you have mastered the analytical toolbox through your PhD training, churning out research output that may be simply the result of repeatedly applying well-worn techniques… the amount of true innovativeness may be limited. Much more creativity is required from those who can come up with applicable actionable breakthroughs and hard industry knowledge.”

Then on page 43, Triana supports his solution by quoting the former dean of MIT Sloan School of Business, Richard Schmalensee: “The academic system’s current methods for hiring and rewarding professors don’t necessarily attract or encourage the kind of practitioner-oriented faculty we need to make business-school research and MBA education much more attuned to meeting today’s and tomorrow’s management challenges.”

Point made, Mr. Triana. Point made.

Anytime you take a position in this game, measuring time and space is critical. When it comes to timing a short position, I don’t think I ever really had anyone teach me in real-life never mind at school. Maybe that’s what makes me better than bad at shorting stocks. I teach myself by doing. I learn to fail with pride. And, in most cases, I try to do so “fast and cleanly.”

My immediate term support and resistance lines for the SP500 are now 1178 and 1189, respectively. For now, by all of +0.10% my current short position in the SP500 (SPY) is in the black. I raised the Cash position in the Hedgeye Asset Allocation Model to 64% yesterday.

[Four Seasons] “We’re starting to really get a significant amount of weekend and even some midweek business, non-gaming business.”

[Sites 5 & 6] “We originally expected Phase I and Phase II to open somewhere late in ‘11 and beginning first quarter of ’12, where we would have about 4,300 rooms available and eventually 6,000 rooms available I think by the end of that first quarter.”

SINGAPORE

“MBS is about 80% open, meaning all the hotel rooms are open, 75% of the expo is open, 150 of about 280 stores and shopping are open, and the event plaza is open. So what’s left is some stores.”

“Present occupancy levels running mid 70s and perhaps the highest rate in Singapore in U.S. dollars—about $270 a night.”

“We expect to do EBITDA margins between 50 and 60% when we fully ramp up in Singapore.”

“And I think of real importance is the retail market. We have 150 stores open. We are running the revenues at about half of what the anticipation is because it’s in a growth model. When that ramps up, we expect to have EBITDA numbers out of the retail area between 150 and $200 million hopefully, that’s why it was built that way, and eventually be able to sell that at a very good multiple and pay down debt and get some cash out. So there’s growth there.”

[available plots around MBS] “They’re all taken.”

[IPO in Singapore?] “No.”

JAPAN

“ We expect the tender to take place in ‘12. We are one of the leading if not the leading candidate for the integrated resort part of that [Casino] bill. That bill will include, we think, two integrated resorts, one in Tokyo, one in Osaka, and then a myriad of other small casinos in other places such as Okinawa and other suburban areas around those small areas around Japan. If in fact we win our tender in ‘12, we figure the earliest we could get open would be ‘15 and the latest would probably be the beginning of ‘16.”

“Not at the beginning but eventually 25,000 slots. It’s a big market. And what I planned to do is open up with 5 or 10,000 slots, about our warehouse some space and build the floor and build the infrastructure that I could put in a lot more slots. Well, I won’t go to Okinawa.”

“So, Tokyo would be a preferred location, second or maybe equal would be Osaka. Both of them we’ve been to, we’ve looked at very specific locations, one – and well I don’t want to mistakenly spot it out, one of the very, very good location is serviced by public transportation. And the Osaka is very, very good, very and excellent roadway system.”

Q2 Conference Call

LAS VEGAS/BETHLEHEM

[On rates] “I think we’ve been averaging on weekends between $240 and $260….For 2011 group rates, we’re trying to stay above 200 bucks. In some groups, we are getting higher than that. I can’t tell you that we are there yet. We have some business with lag that goes back six to eight months.”

“Looking ahead, we expect to realize more group rooms in 2010 than we did in 2009. The pace of group bookings continues to improve and 2011 should be stronger than 2010.”

“We are comping less on a relative basis year on year, but it’s still too high. We’re still in the mid-20s. I think we’re probably less guilty than our competitors, but we’re still guilty of it. Weekends are not the issue. We can get FIT and others on the weekends. The midweek has been the challenge. And I think across the market there is too much comping, but there is also too much supply in the market right now. So until we see stronger group, stronger FIT, I think you will see that continue to be a problem for us and for the market in general.”

“We restarted the construction of our 300-room hotel for Sands Bethlehem and expect it to open in the spring of 2011.”

“Group business % for 2010, we are hoping to get into the mid 20s. I think we’ll see ‘11 will exceed – hopefully, will exceed 30, but we are not there yet.”

SINGAPORE

“Although we expect as much as $450 million of that amount [$750MM] to be paid out of cash flow generated by Marina Bay Sands during the remainder of the year, an additional $430 million, principally retainage payments on the development, will be paid out of cash flow from operating the property in 2011.”

[Rolling volume] “But as you get into the beginning of June, that number has ramped up significantly where it was above the $600 million range, and now in the 8 to $900 million range on a weekly basis.”

“The non-rolling and slot per day, when you started off in May, were kind of in the 2 million plus range per day, and then when you’ve gotten to the beginning part of June, it started to go upwards, pushing into the 2.5 million range. And now as we have progressed into late June and into the early part of July, it’s kind of pushed up above the US$3 million per day…. Our hold number on the VIP rolling situation has been lower than expected, but we are very consistent in our mass market and slot wins.”

“By September 3, we will have a total – we will have over 300 electronics, including Rapid Roulette and Rapid Sic Bo. Some of that will come in August, but the whole project will be completed by September 3.”

[Commission rate] I would say, 1.2 to 1.3, something like that is where it is going to be.

“Casino margin varies, 52-55% depending upon the day…. The overall margin of 43.7 is probably dragged by the hotel and the various expenses.”

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10/26/10 02:21 PM EDT

BYI FQ1 PREVIEW

Estimates have come down 10c through the quarter. We think that is about right.

We know slot demand was not strong during the quarter and we're pretty sure Konami and WMS had good quarters. that probably means BYI's slot sales were weak. Good thing that BYI is not overly reliant on box sales.

We’re in-line with consensus estimates of $0.46 and $184MM of revenue. Expectations are very low going into this call. The sentiment in the investor community is that BYI will have a bad quarter. We don’t necessarily disagree but think that they can offset some of the weakness in machine sales with lower SG&A and other expenses to eke out an in-line quarter.

1Q2011 Detail:

Gaming equipment revenue of $54MM and gross margin of $27MM

We assume 3,300 slot sales (1,950 to North America and 1,350 Internationally)

ASP of $14.5k

$6.4MM of parts and other sales

Systems revenue of $51MM at a 72% margin

$78MM of gaming operations revenues at a 71% margin

25 unit increase in WAP units and flat LAP units

100 unit increase in premium daily fee games

All other units flat

Other stuff:

$50MM of SG&A

$21MM of R&D

$6MM of D&A

35.8% tax rate

56.6MM shares outstanding

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